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Cisco: Secure 3.5% Yield With Big Room To Grow

May 04, 2020 10:25 AM ETCisco Systems, Inc. (CSCO)33 Comments


  • Cisco Systems designs, manufactures and sells IP-based network solutions, products, and related services, which are at the heart of the growing IoT revolution.
  • Cisco operates in a somewhat mature market, but the launch of 5G networks and Cisco's change in business strategy with "Silicon One" could reignite growth.
  • Even with slow or no real revenue growth, Cisco continues to generate robust free cash flow, which will allow dividends and buybacks to continue to rise.
  • Cisco is grossly undervalued after the sell-off in March. I rate Cisco as a conviction buy at the current price of $41 for DG investors.
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Source: www.futurumresearch.net

Investment Thesis

After the recent sell-off (to put it lightly), Cisco (NASDAQ:CSCO) has come to trade at a level where long-term dividend investors can add it to their portfolios with conviction. At $41 a share (and a 3.45% dividend yield), Cisco’s stock is grossly undervalued, as I will demonstrate later in this article.

Since Cisco is seen as something of a bellwether for global economic trends, it's justifiably being substantially discounted; however, the pessimism priced into the stock is excessive and has created an opportunity to generate solid returns. However, to be clear, I don't view these returns as blockbuster by any means, but they're rather secure. Further, the company yields a solid 3.45% dividend, and I am all about catering to dividend growth investors as much as I am about catering to high growth investors.

To be sure, Cisco’s revenue growth is projected to be underwhelming yet again; however, there's hope yet on the horizon! I've predicated my investment thesis contained herein on a few factors:

  • 5G technology’s official arrival (which will entail an uptick in routing & switching device demand),
  • Cisco’s network disaggregation (hardware and software independence), and
  • Adoption of a subscription model for its software & services.

Even with insignificant growth over the last decade, Cisco has managed to enhance shareholder value via stable, rising dividends (9 years running heretofore) and stock buybacks. Cisco’s market leadership and financial strength should enable it to continue in this vein for the foreseeable future.

To put it concisely, I view Cisco as a fantastic opportunity for investors who strive for a robust, consistently growing dividend income (from the first day of purchase) with the potential for long-term price appreciation.

Outline of Today's Research Note

  1. Cisco: Business Overview
  2. A look into Cisco’s financials
  3. Estimation of a fair value

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This article was written by

Louis Stevens profile picture

Louis Stevens offers a proprietary approach to equity (stock) investing.

Employing his Four Foundational Investment Frameworks, Louis purchases industry-leading businesses that possess mountainous cash hoards, robust free cash flow generation, long runways for growth, and quality company cultures.

Here is a snapshot of the performance of the companies selected using these frameworks: https://www.tipranks.com/experts/bloggers/louis-stevens

Whether you're just getting started or are an analyst at a hedge fund, Louis has served folks like yourself throughout his career in equity research and investing. Learn more.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (33)

Algorithmic profile picture
@Louis Stevens nice article. You mentioned that you liked posts that give you an insiders perspective on CSCO.

During the growth years, CSCO bought most of its technology and paid for it in CSCO stock. My brother and I have owned it since 1997. What this means is that the dilution was massive, the shelf of sellers was huge (because they were ex-owners) and that is one of the reasons the stock has been a laggard since dot-com.

The culture is a top 80, like Oracle, meaning the bottom 20% of sales reps, don't survive the year. A juggernaut sales mentality.

The shift to subscription based services. The computer industry is making this shift, especially towards maintenance. In CSCO's case, their EULA agreements, only go in one direction, UP. This means that over time, unless the buyer is very, very careful, they end of paying for maintenance they don't need. Very profitable. Last time I saw their 10-K, 30% of Sales was maintenance.

What did Larry Ellison say? "Maintenance is where great technology companies go to die." Here is hoping for a good Quarter. I re-established a position in March 2020.
Louis Stevens profile picture

So I think we're in the same camp here.

It's taken almost two decades for the company to recover from the culture and irrational exuberance that was created during the dotcom bubble.

This next decade may be its renaissance in terms of SPY outperformance, solely because the company has gotten so cheap and untrusted (in terms of generating Alpha).
European investor 99 profile picture
I love Cisco, I think they are well positioned on a long term, just dont understand why they cant break out of this low 40s range since March. There are other competitors on the market who are already doubled or went significantly higher while CSCO still sits the same spot +-5% sideways. I added some recently and waiting for earnings. IF goes up I am happy I hold it, if goes down I will buy in more for long term hold.
Louis Stevens profile picture
@Stock nomad

What's your objective here?

Safe yield that can grow or to outperform an index fund? Or a mixture of both?
European investor 99 profile picture
@Louis Stevens thanks for asking. I think a bit of both, but I expect that they are becoming stronger due to COVID long term effect. After all it is a network, Security, internet, videoconferencing....etc. company. Might not be as innovative as ZM or ZS, but they are a giant with the cash and big corporate market contracts with reliability and safety. It is more important for large(or small) businesses than fancy user interface.
Who can benefit from this as tech company if not them and the rest (MSFT, Chipmakers...etc.) + of course the obvious home streaming/delivery/pharma industries? I rather put my money into a diverse reliable Cisco than overhyped Zoom or Zscaler with one single fancy product.
Louis Stevens profile picture
@Stock nomad

Of course, you'd/we'd not want to buy ZM at $170.

But wouldn't you want to buy it at $70 where we originally bought it?

It's all about identifying value and acting accordingly.

CSCO is an extremely low-risk investment and investors will be compensated accordingly.
Dividend Latitude profile picture
Thank you for a nice article on CSCO, Louis
LazyGringo profile picture
As you can see, there is one sector which is not really hurt by Covid 19 and quarantines, and that is the internet. CSCO is a backbone of the internet stock. AAPL is the dominant platform, hardware and services internet stock. T and VZ are the broadband providers. And VIAC is my pick as bargain basement double or triple candidate now and also supply home entertainment as do T and Apple. All of these stocks pay dividends and keep the income rolling in. All of them are more or less undervalued and all will survive Covid 19 quite nicely. I own all of them too as a disclaimer and am bullish on them all. I would own Amazon, Google, Facebook and Netflix too but prefer dividend stocks and they and Microsoft seem more or less too richly valued for my taste. Also, 5G will benefit all of these stocks that I own, some of them greatly, and 5G is now coming very soon.
you should also consider Qualcomm, if you like dividend paying companies that are set to benefit from 5g
Louis Stevens profile picture
@Prince_0f_Uranus @LazyGringo

Qualcomm, broadcom, Cisco...

We discuss all of these in our marketplace service.

We offer them as alternatives to yield seekers who have historically bought oil.

Try us out for free: seekingalpha.com/...
Vandooman profile picture
Good article. Another way of looking at buy backs. Management loves them because of tax matters but more so because a dividend cut has serious implications while on the surface cancelling buy backs does not. So to raise a dividend you have to have confidence that it is sustainable. That gives me more confidence in the future than a buy back. I also have financed many a takeover where a goodly part of the price paid was from cash on the acquired company's balance sheet. That is another big reason for buy backs, to rid themselves of the cash that could make them a target. Finance your own takeover and the CEO and CFO get fired.

Buy backs can increase EPS but a dividend increase means management has confidence in the future. An increase in EPS does not automatically translate into a share price increase because the PE ratio may decrease. A series of dividend increases can be more effective. And any advantage from buy backs can collapse if you cancel them. I don't hate buy backs but there is more to them than the math. Investor sentiment counts.
LazyGringo profile picture
Here is my non-technical hunch feeling analysis of CSCO. At 41 it is kind of a no-brainer buy, still near its bottom, which seems to be around 37 on a bad selloff day, therefore the downside is minimal, And any slowdown or lost market share news is more than priced in. Plus I understand that all their customers who have put off spending in the last year or so must spend that money for big upgrades soon, so lost profits from 2019-20 are simply being pushed into 2021-2022. I see they are offering customers attractive credit too, like down 5% now and owe them 95%. Kind of like buying a car or an iPhone if you use a 36 month plan. And this crisis and if this shutdown has proven one thing is that the world needs more bandwidth, more internet, more steaming HD, more expansion of internet services and then 5G makes upgrades mandatory for everyone. So CSCO is in a sweet spot and I assume they are smart enough to execute and learn from any past mistakes. So yes this is a BUY now at 41 fro sure as they should be able to return to last year's high at least in the next 18 months, and that is about a 25% profit from here, plus you get a dividend as high or higher than anything you can safely get from bonds. and CSCO is a safe company with a safe dividend and these days that counts for a lot. That is why I have 95% of my money in four stocks; mostly AAPl, then CSCO, T and VZ, with the knowledge that these days especially the internet is king. In fact internet useage during the crisis is up around 100%.
I'm a retired IT network engineer for a large hospital. We were a Cisco shop for almost 20 years. But tight budgets started to force management to look for cheaper alternatives. I personally am still a big fan of Cisco gear. But that didn't stop management from moving to Juniper and Palo Alto to save a considerable amount of money, both on the front end purchase and the long term maintenance.
Cisco has been pricing itself out of the market by changing their model from a seller of hardware to a seller of software and software licensing.
From a purchase standpoint, I hated that new model, it made it harder for us to purchase.
From a Cisco revenue perspective, it was the right move, it just could have been done much better.
I own some Cisco stock still, and will add to my position if the price drops down to the mid 30's again.
Louis Stevens profile picture
@Naked Stranger

Awesome account of your personal experience!

Love these types of comments.
Chris Valley profile picture
It is also interesting about palo alto networks- they have the highest average wage of any tech company. So that's a good combination, with the affordability.

Selling Jun 39/45-46 ratio short strangles in Cisco.
We'd heard this same story over and over again, ad nauseum. "Big room to grow." Yeah, after looking at its plummet late Feb. to early April.

Not a stock to put your faith and money in.
Louis Stevens profile picture

At 50, I wouldn't have recommended it. At 60, I wouldn't have recommended it.

At 40, it's more compelling...
Where have you been the past couple of months? Most stocks plummeted from late February to April.
kos47 profile picture
The last time I bought Cisco was on 3/12/20 for $34.56. I will buy it again at ~36.00 and not more. If I miss the opportunity of a lifetime to buy it at the current price of ~$41.00 so be it, it’s not the first time and it won’t be the last.
Allinvestor profile picture
A lot depends on that 8% FCF growth you are assuming. What did you base that on?
Louis Stevens profile picture

Hey thanks for the question,

So they've grown their fcf per share at 11% over the last 5 years with anemic growth.

They will be able to sustain 5% annualized free cash flow per share growth by simply buying back 25% of their float over the next 10 years (extremely doable).

So management needs to literally muster 3% average annualized growth over the next 10 years in an industry growing at 7% CAGR...

If management can't achieve that, then the whole board and c-suite will need to be wiped out.
Allinvestor profile picture
Thanks for elaborating - I agree with you on that. Long CSCO by the way, but will be closely monitoring their deteriorating market share vs. the likes of ANET as growth has been sub-par in the past couple of years and these market dynamics could be concerning long-term.
Buyandhold 2012 profile picture

Does it concern you that the 5 year expected PEG ratio of Cisco is 2.52?
Louis Stevens profile picture
@Buyandhold 2012

Hi friend,

I don't use PEG too much. Just mostly calculate out where FCF per share will be by 2030, then use a conservative P/FCF to arrive at a target price.

Then use the current price and target price to arrive at a CAGR.

Very straightforward and the whole process is coded into my website
Buyandhold 2012 profile picture

Thank you for your reply.

Free cash flow has been getting a lot of attention lately.

I'll start to pay more attention to it.
Chris Valley profile picture
[Most of your holdings in the lower yielding stocks tend to have a high free cash flow and lower debt as well.]
It seems like this analysis was written before the Pandemic. The world has changed since.
Most of the world is now in a depression, a quarter million dead, high unemployment.
If Cisco is to hold its 3.5% dividend it better take out a loan at these Zero rates and buy back a massive amount of shares.
Hauwei will not be as big a factor since I see Nokia and Erickson getting together on 5G. Besides Cisco has no radio to do 5G, only thing Cisco can do is backbone, security, you either
have radios or you don't have 5G.
The Chinese have lost good will, with how they lied about the pandemic not being human to human. China horded the Protective equipment, and sold faulty protective gear, faulty respirators and ventillators, and masks. China tried to foreclose on poor African countries.
They hid the truth, lied, and refused to let the world scientist in to study the virus.
I don't think their spyware laden gear will be in too many networks. A a former Telecomm manager I would never by spyware gear from known liars.
Cisco makes stuff related go computers and internet. there are more computers and more internet everyday so Cisco will continue to grow.
Louis Stevens profile picture

I mean it should!

We'll see if management can take advantage of the massive opportunities before it.
Dividend Ambassador profile picture
CSCO is a great great company and it is one of my largest holdings out of about 70 different positions. However, one must be patient w purchases of CSCO. CSCO is a company that the market periodically likes to hate. It is often available (if your timeframe is years not months) at significant discounts to fair value. If you are patient you can certainly buy CSCO even cheaper than CSCO currently sells for. My rule of thumb is to ONLY buy CSCO when yield is at or above 4%. It has served me very well.
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